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Best Practices to Build Value Drivers

October 31, 2014

Posted by Aaron Miller

Posted in Quantify Customer Value, User Content

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In value modeling, the key step is the quantification of economic value, or what is sometimes referred to in the U.S. as “dollarization.” In LeveragePoint, this is when you’re adding or creating value drivers.

At its core, each value driver is a miniature comparative analysis of your product offering versus the next best alternative, referencing a single, discreet impact. Simply put, each value driver answers your customer’s two most important questions: what’s the difference between the two options, and how much more is your product offering worth to me?

Creating new value drivers can seem a daunting task; but there are really only a few basic types of calculations you will ever need, as these will cover just about any use case. Once well understood, each type can be quickly expanded to drill down in further detail.

Formula 1: Custom Value

The first formula is actually not a formula at all, but a single number (custom value in LeveragePoint), representing a flat cost savings or additional revenue generated by using your product offering instead of the next best alternative.

But remember that every value driver is a comparative analysis. For cost savings, the implication is that your product offering eliminates the entire cost, which is only incurred by using the next best alternative. Conversely, with a revenue driver, the implication is that the entirety of the additional revenue you help generate is lost by using the next best alternative.

For example, by using your product offering, the customer can avoid a $10,000 installation fee which your competitor charges, and you do not.

Which leads to the next value driver calculation type.

Formula 2: Direct Comparison of Value

For cost savings value drivers, “a” represents the cost incurred using the next best alternative, while “b” represents the cost incurred using your product offering. For revenue drivers, the order is reversed; “a” is the revenue generated by your offering and “b” is revenue associated with the next best alternative. In either case, the difference is your advantage.

For example, by using the competitor offering, the customer may gain $250,000 in additional revenue per year, but with your solution, they might gain $1,000,000, or a net of an additional $750,000.

To drill down in further detail, convert either of the two variables to a subformula calculation to demonstrate how each number was assessed.

Another way to look at this comparative advantage would be by a percent reduction in cost or increase in revenue associated with your product offering.

Formula 3: Value Comparison by Scale

Though the order of the variables technically doesn’t matter, it usually makes the most sense to set up the value driver so that “a” represents a specific cost or revenue line item in a currency format, and “b” is the percentage by which your product offering improves the customer’s economics versus the next best alternative.

For example, by using your product offering, the customer can save 25% on their energy use in manufacturing, which currently costs $20,000,000 per year, resulting in a savings of $5,000,000.

Again, you can drill down by converting either variable to a subformula. For “b” (the improvement percent), this would look like:

In this subformula, “b” represents the before and “a” represents the after, similar to a weight loss commercial. More precisely, “b” represents your product offering, and “a” represents the next best alternative. In this subformula, both variables “a” and “b” are percentages.

Using the same example, the 25% energy savings may be broken down as a 50% reduction using your product offering versus only a 40% reduction with the competitor.

(50%-40%)/40% = 25%

Another way to drill down in Formula 3 is to focus on “a,” the budgetary line item. Rather than converting it to a subformula, this leads to a different type of calculation.

Formula 4: KPI Comparison by Scale

Here, the specific cost or revenue line item from Formula 3 is broken into two distinct parts, including a non-financial customer metric or key performance indicator (KPI) and a dollarization of that line item.

Let’s return to the same energy consumption example. Rather than estimating the customer’s energy spend on an annual basis directly, let’s break that out into a number of hours spent operating a plant, and an energy cost per hour. Your product offering may impact either of these variables, either reducing the number of hours needed to achieve the same production capacity, or decreasing the cost of the energy on an hourly basis. Whichever one you pick should be variable “a,” and the other “c.” The “b” variable is placed between them because it represents an impact on “a;” that is, it estimates the improvement or benefit of your product offering versus the competitor with regard to that first variable.

6,000 hours * 25% reduction in time * $3,333.33/hour = $5,000,000

By using these formulas, you can build a value driver for almost any business and any situation. Again, you can expand by converting any variable to a subformula. But, it’s important not to stray too far from these simple high-level formulas. In the end, they’re not just easier to build, but they’re easier for sales to communicate to customers, as well.

To access the white paper How to Put a Value Tag on Your Product by Ed Arnold, click here.


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